Does This Advertising Middleman Add Up?

Seeking stocks that others ignore, shun, or simply forget gives individual investors like you an edge over the professionals. Getting in before Wall Street discovers them -- or rediscovers them -- means you can stake a claim before they start taking off.

In this column we check out companies with minimal analyst coverage at best, then pair our list with the opinions of the Motley Fool CAPS community. A stock that garners CAPS' top ratings, but hasn't yet caught analysts' attention, could be your next home run investment.

On the surface, advertising middleman Digital Generation (NAS: DGIT) looks like it could be that one. Wall Street likes it, as four of the five analysts on CAPS tracking it rate it to outperform the market averages, and the investment community is behind it as 94% of those weighing in on it see it beating the Street. Let's see if that's enough to give you a head start.

Digital Generation Snapshot

Market Cap

$307 million

Revenues (TTM)

$382 million

1-Year Stock Return

(49.8%)

Return on Investment

0.7%

Dividend/Yield

NA/NA

Recent Price

$11.13

CAPS Rating (out of 5)

****

Source: FinViz.com. TTM = trailing 12 months.

Remember: Without much analyst support, you'll have to do more digging on your own to see whether it deserves a spot in your portfolio.

Hiding in plain sightIt's not the agency making up the ads nor is it the one running them. Digital Generation serves as the middleman between the two end points, taking the content from the one and digitally preparing it for display on the other.

Traditionally it has focused almost exclusively on delivering advertising to television and radio outlets, but more recently it has increased its presence in the online market through a series of acquisitions. In 2010, 92% of its revenues were derived from its television segment. In 2011, online revenues accounted for almost a quarter of the total. In the second quarter that just ended, that number had jumped to 36%.

The company has made five acquisitions since October 2010 that have been responsible for the online segment's growth, and though that represents an opportunity, it puts it up against much larger players, notably Google's DoubleClick service, Microsoft's (NAS: MSFT) aQuantive, and ValueClick (NAS: VCLK) division MediaPlex.

There are other risks inherent in this move to online advertising, which will likely impact all of the players in the space. According to a new study published in AdWeek, more than half of all online ads can be seen on a page for less than one second. AdSafe Media, the company that conducted the study, says the industry is using skewed tools to count "viewable impressions," which is ultimately used to determine rates. If change comes, and there are voices advocating for just such an outcome, the whole industry could be upended, just as Digital Generation goes all-in.

Of course, the market researchers at Mintel say that online advertising could surpass television advertising by 2017, perhaps as soon as 2016. Carat says it will surpass newspapers by the end of this year. So it's not that the market's not there, it's just whether it's effective.

East versus WestYet Digital Generation experienced weakness in the second quarter because of the financial unrest in Europe and elsewhere. It was able to achieve 26% penetration into the HD television market, but revenues in the segment were still down 2% from the year-ago period as competition remains tight. Not only does it have traditional ad agencies to contend with, but online shops like Akamai (NAS: AKAM) and Limelight Networks (NAS: LLNW) also distribute video to the established traditional channels. And if DG hadn't made acquisitions, it wouldn't have seen any growth at all in its online segment.

What investors are looking for these days is another acquisition -- of Digital Generation itself! Previously, ad management specialist Extreme Reach offered $20 a share for the company, but was rebuffed, and RDG Capital wonders what price it would take to get a takeover agreement. DG has hired Goldman Sachs to help it navigate strategic alternatives so there just might be a deal made sooner rather than later.

The stock is up 48% from its 52-week lows on the basis of the takeover rumors, but the business seems to be in a fix. It seems a buyout is the best outcome for it, but that's not something that can be counted on to happen.

Considering the above, I'm passing on making a CAPScall here, but let me know in the comments box below if you see a reason to think Digital Generation ads up to a winning investment.

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